Q4 2023 Microsoft Corp Earnings Call
Greetings and welcome to the Microsoft fiscal year, 2023 fourth quarter earnings Conference call.
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I would now like to turn the conference over to your host Brett Iverson, Vice President of Investor Relations. Mr. Robinson. Please go ahead.
Good afternoon, and thank you for joining us today on the call with me are Satya, Nadella, Chairman and Chief Executive Officer, Amy Hood, Chief Financial Officer.
Alice <unk>, Chief Accounting Officer, and Keith Dolliver, Deputy General Counsel.
On the Microsoft Investor Relations website, you can find our earnings press release and financial summary, slide deck, which is intended to supplement our prepared remarks during today's call and provides the reconciliation of differences between GAAP and non-GAAP financial measures.
Our detailed outlook slides will be available on the Microsoft Investor Relations website, when we provide outlook commentary on today's call.
On this call, we will discuss certain non-GAAP items.
The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP.
They are included as additional clarifying items to aid investors in further understanding the company's fourth quarter performance in.
In addition to the impact these items and events have on the financial results.
All growth comparisons we make on the call today relate to the corresponding period of last year unless otherwise noted.
We will also provide growth rates in constant currency when available as a framework for assessing how our underlying businesses performed excluding the effect of foreign currency rate fluctuations.
Where growth rates are the same in constant currency, we will refer to the growth rate only.
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During this call we will be making forward looking statements, which are predictions projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties.
Actual results could materially differ because of factors discussed in today's earnings press release in the comments made during this conference call and in the risk factors section of our Form 10-K forms 10-Q, and other reports and filings with the Securities and Exchange Commission, we do not undertake any duty to update any forward looking statements and with that I'll turn.
The call over to Satya.
Thank you very much Brett.
We had a solid close to our fiscal year, the Microsoft cloud surpassed $110 billion in annual revenue up 27% in constant currency with Azure, all up accounting for more than 50% of the total for the first time.
Every customer I speak with is asking not only how but how fast they can apply next generation AI to address the biggest opportunities and challenges they face and to do so safely and responsibly.
To that end, we remain focused on three key priorities first helping customers use the breath and depth of Michael.
Okay.
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Second investing to lead in the new AI platform shift by infusing AI across every layer of the tech stack and third driving operating leverage now on highlight examples of our progress starting with infrastructure.
<unk> continues to take share as customers migrate their existing workloads and invest in new ones. We continue to see more cloud migrations as it remains early when it comes to long term cloud opportunity.
Also seeing increasing momentum with Azure arc, which now has 18000 customers up 150% year over year, including Carnival Corp, Dominoes, Thermo Fisher and Azure AI is ushering in new born in the cloud AI first workloads with the best selection of frontier and opened models, including matters recent.
Supporting Lhamo in Azure and Windows as well as open AI.
We have great momentum across Azure open AI service more than 11000 organizations across industries, including Ikea Volvo Group Zurich insurance as well as digital natives like flip got humane Cahoot Miro typeface used the service that's nearly 100, new customers added everyday this quarter Mercedes Benz.
For example is bringing chat GPT via Azure open AI to more than 900000 vehicles in the United States, making it in call voice assistant more intuitive and Moody's built its own internal copilot to improve productivity of its 14000 employees.
We're also partnering broadly to scale. This next generation of AI to more customers Snowflake for example will increase its azure spend as it builds new integrations with Azure open AI and KPMG has announced a multibillion dollar commitment to our cloud and AI services to transform professional services.
Now on to data every hour apps starts with data and having a comprehensive data and analytics platform is more important than ever our intelligent data platform brings together operational databases analytics and governance. So organizations can spend more time, creating value in less time integrating their data and state.
We introduced Microsoft fabric, this quarter, which unifies compute storage and governance with a disruptive business model.
One month in we are encouraged by early interest and usage over 8000 customers have signed up to trial. The service and are actively using it and over 50% are using four or more workloads. All up we once again took share with our analytics solutions with customers like Bridgestone Chevron in Akron or turning to our stack.
Now on to developers new Azure AI studio is becoming the tool of choice for AI development in this new era of helping organizations ground fine to evaluate and deploy models and do so responsibly.
<unk> code and get up copilot of category, leading products when it comes to how developers code every day nearly 90% of Github copilot sign up the self service, indicating strong organic interest and pull through more than 27000 organizations up to X quarter over quarter have chosen get up copilot for business to increase.
The productivity of their developers, including Airbnb, Dell and Scandinavian Airlines.
We're also applying AI across low code no code tool chain to help domain experts automate workflows create apps and web pages build virtual agents or analyzed data using just natural language.
Copilot and power beyond combines the power of large language models with an organization's data to generate insights foster and copilot empower pages makes it easier to create secure local business websites one of our tools, that's really taken off as copilot and power virtual agents, which is delivering one of the biggest benefits of this new era.
AI, helping customer service agents be significantly more productive.
HB and Virgin money for example have both build custom chat bots with copilot and power virtual agents that were trained to answer complex customer inquiries.
All up more than 63000 organizations have used AI powered capabilities in power platform up 75% quarter over quarter.
Finally power automate now has 10 million monthly active users that companies like Jaguar land Rover, Repsol Rolls Royce up 55% year over year.
And we're going further with new process mining capabilities and power automate, which are helping organizations optimize business processes and in done build the AI advantage.
Now onto business applications, we have.
Taking share in every category as we help organizations across the private and public sector from Avis to Albertsons to brand little to equinox and the U S Department of Veterans Affairs transform their mission critical business processes.
All up dynamic surpassed $5 billion in revenue over the past fiscal year with our customer experience and service and finance and supply chain businesses, all surpassing $1 billion in annual sales. This quarter. We brought dynamics 365 co pilots to our ERP portfolio, including Finance project operations and <unk>.
Apply management.
And with our new Microsoft sales copilot sellers can ground their customer interactions with data from CRM systems, including both Salesforce and dynamics to personalized customer interactions and close more deals now.
Now on to our industry and cross industry clouds are Microsoft cloud for sustainability is helping customers like Costco lateral lakes and Rei take action to meet their environmental goals and in health care hundreds of organizations are using a nuance dax ambient intelligence solution to automatically document patient encounters at the point.
Ken this quarter, we expanded our collaboration with epic to integrate nuance stacks express directly into their industry, leading EHR system.
Now on to future work.
Across industries customers like April Delhaize, Deutsche Bank Novartis, Siemens Wells Fargo are choosing Microsoft 365 premium offerings for differentiated security compliance voice and analytics value and.
And four months ago, we introduced a new pillar of customer value with Microsoft 365, Copilot. We are now rolling out Microsoft 365, Copilot to 600 paid customers through our early access program and feedback from organizations like Emirates, NBD General Motors Goodyear and lumen is.
It's a game changer for employee productivity, we continue to build momentum in Microsoft teams across collaboration chat meetings and calling we now have more than 1900 apps and teams App store and companies in every industry from British Airways to dentsu to Eli Lilly and Manulife has built over 100.
45000 customer line of business apps, bringing business process directly into the flow of work.
Five months in teams premium has already surpassed 600000 seats as companies like being why Mellon Clifford chance Pepsico and Starbucks chose the add on for advanced features like end to end encryption and real time translation.
Teams phone as the market leader in cloud, calling with more than 17 million PSTN users up 45% year over year.
Teams room is used by more than 70% of the fortune 500, including L'oreal, United Airlines and U S Bank in revenue more than doubled year over year this quarter.
And with Microsoft Viva, we are creating a new market category for employee experience Veeva now has 35 million monthly active users as companies like CBRE, Fujitsu and Unisys John to the platform to build data driven high performance organizations.
Now onto Windows, the number of devices running Windows 11 has more than doubled in the last year and we're seeing continued growth in windows 11, commercial deployments worldwide by companies like AT&T Kronos and Westpac.
We're also transforming how windows is experienced and managed for enterprise customers with Azure virtual desktop and Windows 365, which together surpassed $1 billion in revenue for the first time over the past 12 months Enbridge Euro wings Marriott International and TD Bank Group for example, all chose cloud delivered.
Does this quarter.
<unk> 11 is also rapidly becoming a powerful new canvas in this new era of AI, we introduced windows Copilot. This quarter, helping every windows 11 use will become a power user with just natural language and are excited to put it in the hands of more people in the coming months.
Now onto security more than 1 million organizations now count on our comprehensive AI powered solutions to protect their digital estate across clouds, and endpoint platforms up 26% year over year.
More than 60%, including leading enterprises like ABN Amro, Dow and Heineken used four or more of our security products up 33% year over year underscoring our end to end differentiation and we once again took share across all major categories. We serve as we innovate to protect customers in <unk>.
The entity, Microsoft and try it he has more than 610 million monthly active users and we are adding <unk> to our <unk> product family to complement our leading identity solution and secure access to Amy Apple resource from anywhere.
Finally, our security copilot, the first product to apply this next generation of AI to SEC ops will be available to customers via paid early access program. This fall.
Now onto Linkedin.
Linkedin revenue surpass $15 billion for the first time this fiscal year and membership growth has now accelerated for eight quarters in a row, a testament to how mission critical the platform has become to help more than 950 million members connect loan sell and get hired.
Talent solutions business about $7 billion in revenue for the first time over the past 12 months and are hiring business took share for the fourth consecutive quarter.
We continue to use AI to help our members and customers connect to opportunities and tap into experiences of experts on the platform.
AI powered collaborative articles are now the fastest growing traffic driver and Linkedin and finally, we are helping Linkedin state trusted and authentic more than 7 million members have ratified who they are or where they work many using new integrations with Microsoft and trust as well as clear and hyper woods.
Now on to search advertising and news while it's early in our journey, we are reshaping daily search and web habits with our co pilot for the web this quarter, we introduced new AI powered features including multimodal capabilities with visual search and being chat, we're expanding to businesses with being chat enterprise.
Office commercial data protection, providing an easy on ramp for any organization looking to get the benefit of this next generation of AI today.
<unk> is also the default search experience for opening eyes chat GPT, bringing timely answers with links to our reputable sources to chat GPT users.
To date being users have engaged in more than 1 billion chats and created more than 750 million images with being image creator and Microsoft edge took share for the ninth consecutive quarter.
More broadly we are growing our AD network, which is now available in 187 market spanning search display native retail media video and connected TV.
Now on to gaming last week, we extended our Activision Blizzard merger agreement deadline to October we continue to work through the regulatory approval process and remain confident about getting the deal done.
We are committed to bringing more games to more players everywhere great content is key to our approach and our pipeline has never been stronger.
We announced our most ambitious lineup of games ever at our showcase last month, including 21 titles that will be available via Xbox game pass and we're looking forward to the release of Star field. This fall, but test its first new universe in 25 years.
All up we set new fourth quarter highs for monthly active users driven by strength off console as well as monthly active devices and we saw a record fourth quarter engagement across game pass with hours played up 22% year over year and just last week, we announced game pass call, bringing together online play.
From Xbox live and content from game pass into a single offering.
In closing I'm energized about the opportunities ahead, we continue to innovate across the tech stack to help our customers thrive in the new era of AI and with that let me turn it over to Amy.
Thank you Staci and good afternoon, everyone. This quarter revenue was $56 $2 billion up 8% and 10% in constant currency earnings per share was $2.69 and increased 21% and 23% in constant currency and our largest quarter of the year results exceeded expectations with focused execution.
<unk> by our sales and partner teams.
These execution efforts led to share gains again, this quarter and Azure dynamics security and edge and our commercial business. We continued to see healthy renewal strength, which includes our upsell and attach motion, particularly with Microsoft 365 five.
Growth of new business continued to be moderated for products sold outside the Microsoft 365 suite, including Standalone office, 365, EMS and Windows commercial products as expected in Azure, we saw continuation of the optimization in your workload trends from the prior quarter.
In our consumer business. The PC market overall was in line with expectations. Although the early timing of back to school inventory barrels benefited windows OEM advertising spend was slightly lower than anticipated, which impacted search and news advertising and Linkedin marketing solutions.
Commercial bookings decreased 2% and 1% in constant currency in line with expectations against the prior year comparable that was our largest commercial bookings quarter ever and.
In addition to the healthy execution across our renewable sales motion as mentioned earlier, we saw a record number of $10 million plus contracts for both Azure and Microsoft 365.
And the average annualized value for our large long term azure contracts was the highest it's ever been driven by customer demand for our innovative cloud solutions today as well as interest in AI opportunities ahead.
Commercial remaining performance obligation increased 19% and 18% in constant currency to $224 billion, roughly 45% will be recognized in revenue in the next 12 months or 13% year over year. The remaining portion which will be recognized beyond the next 12 months increased 22% and this quarter are new.
The mix increased to 97%.
FX impact on total company revenue segment level revenue to operating expense growth was as expected FX decreased Cogs growth by 1.1 point favorable to expectations Micros.
Microsoft Cloud revenue was $30 $3 billion and grew 21% and 23% in constant currency slightly ahead of expectations.
Croissant cloud gross margin percentage increased roughly three points year over year to 72% also slightly ahead of expectations.
The impact of the change in accounting estimate for useful lives Microsoft cloud gross margin percentage increased slightly driven by improvements in office 365, partially offset by lower Azure margin and the impact of scaling our AI infrastructure to meet growing demand.
Gross margin dollars increased 11% and 13% in constant currency, including two points due to the change in accounting estimate gross margin percentage increased year over year to 70%.
Putting the impact of the change in accounting estimate gross margin percentage increased slightly driven by improvements in office 365.
Operating expense increased 2% inline with expectations of savings across the company from our focus on prioritization and efficiency were offset by the charge related to the Irish data Protection Commission matter.
Total company level head count at the end of June was flat compared to a year ago.
Operating income increased 18% and 21% in constant currency, including four points due to the change in accounting estimate.
Operating margins increased roughly four points year over year to 43% excluding.
Excluding the impact of the change in accounting estimate operating margins increased roughly two points driven by improved operating leverage through disciplined cost management.
Now to our segment results.
Revenue from productivity and business processes was $18 3 billion and grew 10% and 12% in constant currency ahead of expectations with better than expected results in office commercial partially offset by Linkedin.
Office commercial revenue grew 12% and 14% in constant currency.
365, commercial revenue increased 15% and 17% in constant currency a bit better than expected with particular strength in <unk> upsell at renewal noted earlier.
Paid off the 265 commercial seats grew 11% year over year with installed base expansion across all workloads and customer segments seat.
<unk> growth was again, driven by our small and medium business and frontline work our offerings.
Office commercial licensing declined 20% and 18% in constant currency with better than expected transactional purchasing office consumer revenue increased 3% and 6% in constant currency with continued momentum in Microsoft for 65, subscriptions, which grew 12% to $67 million.
Linkedin revenue increased 5% and 7% in constant currency driven by growth in talent solutions with some continued bookings impact from the weaker hiring environment in key vertical growth was partially offset by a decline in marketing solutions due to the lower AD spend noted earlier.
Dynamics revenue grew 19% and 21% in constant currency driven by dynamics, 365, which grew 26% and 28% in constant currency with continued healthy growth across all workloads.
Segment gross margin dollars increased 14% and 16% in constant currency and gross margin percentage increased roughly three points year over year.
Excluding the impact of the change in accounting estimate gross margin percentage increased roughly one point driven by improvements in office 365, operating expenses decreased slightly and operating income increased 25% and 29% in constant currency, including three points.
<unk>, an accounting estimate.
Next the intelligent cloud segment.
Revenue was $24 billion, increasing 15% and 17% in constant currency slightly ahead of expectations overall server products and cloud services revenue increased 17% and 18% in constant currency.
As you and other cloud services revenue grew 26% and 27% in constant currency, including roughly one point from AI services as expected.
In our per user business, the enterprise mobility and security install base grew 11% to over 256 million seats with impact from the continued growth trends in new business noted earlier.
And our on premises server business revenue decreased 1% and was relatively unchanged in constant currency driven by a slight decrease in your annuity contracts, which carry higher in period revenue recognition.
Enterprise services revenue grew 4% and 5% in constant currency with better than expected performance across enterprise support services and industry solutions.
Gross margin dollars increased 16% and 17% in constant currency and gross margin percentage increased slightly.
The impact of the change in accounting estimate gross margin percentage declined roughly two points driven by sales mix shift to azure and the lower our Azure margin noted earlier.
Operating expenses increased 10% operating income grew 20% and 22% in constant currency with roughly six points from the change in accounting estimate.
Now to more personal computing.
Revenue was $13 $9 billion, decreasing 4% and 3% in constant currency above expectations, driven by better than expected performance in windows, partially offset by gaming Windows OEM revenue decreased 12% year over year ahead of expectations due to seven points of benefit from early back to school inventory build.
While the overall PC market was as expected.
Devices revenue decreased 20% and 18% in constant currency roughly in line with expectations.
Windows commercial products and cloud services revenue increased 2% and 3% in constant currency ahead of expectations due to the renewal strength noted earlier, even with the moderated growth of new business and Standalone offerings.
Search and news advertising revenue ex Tac increased 8% a bit behind expectations due to lower AD spend noted earlier higher search volumes share gains again this quarter for our edge browser and the benefit from the Xander acquisition were partially offset by the impact from third party partnerships.
And in gaming revenue increased 1% and 2% in constant currency lower than expected due to weakness in first party and third party content performance.
Xbox content and services revenue increased 5% and 6% in constant currency and Xbox hardware revenue declined 13%.
Segment gross margin dollars declined 2% and were relatively unchanged in constant currency and gross margin percentage increased roughly one point year over year, driven by sales mix shift to higher margin businesses operating expenses declined 9% and 8% in constant currency operating income increased 4% and 6% to constant currency.
Now back to total company results.
Capital expenditures, including finance leases were $10 $7 billion to support cloud demand, including investments in AI infrastructure.
Cash paid for PP&E was $8 9 billion.
Cash flow from operations was $28 $8 billion up 17% year over year as strong cloud billings and collections were partially offset by a tax payment related to the R&D capitalization profession free.
Free cash flow was $19 $8 billion up 12% year over year, excluding the impact of this tax payment cash flow from operations increased 22% and free cash flow increased 19%.
This quarter other income and expense was $473 million higher than anticipated driven by net gains on foreign currency Remeasurement.
If tax rate was approximately 19% and finally, we returned $9 $7 billion to shareholders through share repurchases and dividends, bringing our total cash returned to our shareholders to over $38 billion for the full fiscal year.
Now, let's turn to next fiscal year and start with a few reminders.
First the.
The change in accounting estimate for the useful life of server and network equipment wears off.
And $3 $7 billion of depreciation expense shifting from FY2023 to future periods.
Our FY2023 operating income and margins benefited from this change in accounting estimate and that will be a headwind to growth in FY 'twenty four as the benefit reduces to $2 $1 billion.
Next my outlook commentary for both the full year and next quarter is on a U S dollar basis, unless specifically noted otherwise.
And my outlook does not include any impact from the acquisition acquisition, which we continue to work towards closing subject to obtaining required regulatory approvals.
Now.
For some thoughts on the full year of FY 'twenty four with.
With the weaker U S dollar and assuming current rates remain stable, we expect FX to increase full year revenue growth by approximately one point with no impact to Cogs or operating expense growth the impact and each one is expected to be greater in H two.
At a total company level revenue growth from our commercial business will continue to be driven by the Microsoft cloud and will again outpaced the growth from our consumer business.
Even with strong demand and a leadership position growth from our AI services will be gradual.
As Azure AI scale and our co pilots reached general availability dates so for FY 'twenty for the impact will be weighted towards its too.
To support our Microsoft cloud growth and demand for AI platform, we will accelerate investment in our cloud infrastructure, we expect capital expenditures to increase sequentially each quarter through the year as we scale to meet demand signals.
We are committed to driving operating leverage and therefore, we will manage our total cost growth across Cogs and operating expense in line with the demand signals, we see as well as revenue growth.
Increased capital spend will drive higher Cogs growth then in FY2023 in FY 'twenty for operating expense growth will remain low as we prioritize our spend therefore, we expect full year operating margins to remain flat year over year, even with the headwind from the change in accounting estimate.
And finally, we expect our FY 'twenty four tax rate to be around 19% now to the outlook for the first quarter.
First FX.
Just on current rates, we expect FX to increase total revenue and operating expense growth by approximately one point with no impact to Cogs growth within the segments. We expect FX to increase revenue growth in intelligent cloud by one point with no impact to productivity and business processes or more personal computing and commercial bookings strong execution across.
Our core annuity sales motions, including our renewal and upsell motions, along with long term Azure commitments should drive healthy growth on a growing expiry base.
Microsoft Cloud gross margin percentage should decrease roughly one point year over year, driven by the accounting estimate change headwind noted earlier, excluding that impact Q1 cloud gross margin percentage will be up roughly one point, primarily driven by improvements in Azure and office 365, partially offset by sales mix shift to Azure.
And the impact of scaling our AI infrastructure to meet growing demand.
We expect capital expenditures to increase sequentially on a dollar basis as noted earlier driven by investments in our AI infrastructure reminder, there can be normal quarterly spend variability and the timing of cloud infrastructure Buildout.
The segment guidance in productivity and business processes, we expect revenue to grow between nine and 11% or 18% to $18 3 billion U S dollars.
Commercial revenue growth will again be driven by office 365 with seat growth across customer segments and ARPA growth through <unk> five we expect office 365 revenue growth to be roughly 16% in constant currency and our on premises business, we expect revenue to decline in low twenty's.
In office consumer we expect revenue growth to be in the low to mid single digits driven by Microsoft 365 subscriptions for Linkedin, We expect revenue growth in the low to mid single digits, even with share gains in our hiring business growth will continue to be impacted by the overall market for recruiting and advertising, especially in the technology industry.
We have significant exposure.
And then dynamics.
Revenue growth in the mid to high teens, driven by continued growth in dynamics 365 for intelligent cloud, we expect revenue to grow between 15, and 16% of 14 and 15% in constant currency revenue should be $23 three to $23 6 billion U S. Dollars revenue will continue to be driven by Azure, which.
As a reminder, can have quarterly variability primarily from our per user business and from in period revenue recognition, depending on the mix of contracts.
In Azure.
That revenue growth to be 25% to 26% in constant currency, including roughly two points from all Azure AI surfaces.
Growth continues to be driven by our azure consumption business and we expect the trends from Q4 to continue into Q1.
Our per user business should continue to benefit from Microsoft for 65 suite momentum, though we expect continued moderation in growth rates given the size of the installed base and.
And our on premises server business, we expect revenue to decline low to mid single digits against a prior year comparable that benefited from annuity purchasing ahead of the sequel server 2020 too much.
And in Enterprise services revenue should decline low to mid single digits year over year as growth in enterprise support services will be more than offset by a decline in industry solutions and more personal computing, we expect revenue of $12 five to $12 9 billion U S dollars windows OEM revenue should decline low to mid teens <unk>.
<unk> five points of negative impact from the earlier back to school inventory builds that were pulled into the fourth quarter. Our guide assumes no significant changes to the PC demand environment.
And devices revenue should decline in the mid thirties.
Overall, PC market and adjustments, we made in our portfolio with an increased focus on our higher margin premium products.
Windows commercial products and cloud services customer demand for Microsoft 365, and our advanced security solutions should drive revenue growth in the mid to high single digits.
Search and news advertising ex Tac revenue growth should be mid to high single digits, roughly five points higher than overall search and news advertising revenue driven by continued volume strength supported by edge browser share gains.
Growth will continue to be impacted by the advertising spend environment and third party partnerships mentioned earlier, we continue to be excited by being usage signals and the longer term opportunity as we invest in AI and in gaming, we expect revenue growth in the mid single digits, we expect Xbox content and services revenue growth in the mid to high single digits driven by first party.
And third party content as well as Xbox game pass now back the company guidance.
We expect Cogs between $16 six to $16 8 billion U S dollars and operating expense of $13 five to $13 6 billion U S dollars together.
Cost growth should be around 6%.
Other income and expense should be roughly $300 million of interest income is expected to more than offset interest expense. Two reminders. This does not include any impact from Activision on interest income and expense and we are required to recognize mark to market gains or losses on our equity portfolio, which can increase quarterly volatility.
We expect our Q1 effective tax rate to be around 19%.
Finally, as a reminder, for Q1 cash flow, we expect to make a $2 $7 billion cash tax payment related to the T. C. J a transition tax we do not expect the payment related to the R&D capitalization provision in Q1.
And clothing.
As a company we delivered on the FY2023 financial commitments, we discussed a year ago on revenue and operating margin.
Our focus on operational excellence allowed us to achieve these targets, while we delivered near term value to customers and prioritized our investments to continue to lead in the future.
As we start FY 'twenty four.
Excited for the opportunities ahead and remain focused on delivering the three key priorities Satya mentioned.
We will maintain our lead as the top commercial cloud.
Helping customers use the breadth and depth of the Microsoft cloud.
We'll continue to invest in our cloud and AI infrastructure, while scaling with growing demand. So we can lead the AI platform wave and finally, we will align our costs with growth as we are committed to driving operating leverage with that let's go to Q&A Brett.
It's Amy we'll now move over to Q&A out of respect for others on the call. We request that participants. Please only ask one question.
Joe can you please repeat your instructions.
Yes.
Ladies and gentlemen, if you would like to ask a question. Please press star one on your telephone keypad and a confirmation tone will indicate your line is in the question queue. You May Press Star two if you really like to remove your question from the queue.
For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.
One moment, please while we poll for questions.
Our first question comes from the line of Keith Weiss with Morgan Stanley . Please proceed.
Excellent. Thank you guys for taking the question and very nice end to a.
Great fiscal year, sorry, you started your comments talking about every customer conversation has the customer asking you.
About utilizing chair of AI technology, and how fast it could utilize that generative AI technology.
The answer what do you tell them in terms of the pace with which that could get into the marketplace and your customers can start using it and then for Amy how should investors think about just the fundamental gross margins behind these generate AI technologies, we understand theres going to be a lot of capex to ramp up underneath it.
We expect in terms of what the ultimate gross margin it looks like underneath all these new generative AI solutions. Thank you.
Thank you Keith for the question.
The fundamental.
Guidance and organization that we have.
With customers is twofold, one is the easiest path to value auto generated of AI is to adopt certain solutions for example get up co pilot.
And sometimes a total no brainer to productivity leverage for all of the software developers in any organization, whether you are a bank.
All you are a software company it applies to everyone. So that's probably one of the things that we are seeing very good.
Even productivity data and greater adoption.
And then obviously the excitement there is already around the M 365, copilot. So first thing we sort of talked about is how we all felt it deploying all of these co pilots across whether it fails co pilot Tor <unk> hundred six five cope either to get a copilot, how do you get maximum value out of these horizontal tool chain and then on top of that.
We have taken what we did underneath these products and built it out as a first class Tech stack, which we talked at our developer conference called the Copilot stack and then with Azure AI tooling made it possible for someone like Moody's ought to build their own copilot for there.
Paul.
So to us we want to be able to help customers build their generator of AI applications on top of Azure AI.
Speed, if you will and so those are the two things that we ask them to identify where they can get the maximum productivity leverage and then we even swap them with our own resources to help them.
Get those things done.
The last comment I'd make is that cloud and data in the cloud enables all of this because I think the diffusion of the cycle here.
In some sense, we have a new set of cloud meters that are getting adopted faster because of everything else that came before it in the cloud so those would be the observations.
And to your question Keith.
Gross margins and how I think about those.
Going forward. The first thing I would say is I expect gross margins here to transition over time, just like they did in the prior pallet transition I would also say I expect workloads and the gross margins, but of the workloads to be different just like they are in the cloud today.
I'd also add one thing thats different than last time, we talked a bit about this before is that we start out in a different place with more of a shared platform which allows us.
To scale, those gross margins a bit faster.
Then last time and we do expect as you asked and side you talked about the pace.
This adoption curve, we do expect to be faster.
So you're seeing the capex spend accelerate in Q4, and then again in Q1, and we've talked about what it should look like the rest of the year now that being said.
We're talking about all that.
And.
Going through that transition, while delivering an FY 'twenty four over FY2023.
Actively.
Higher.
Operating margins.
If it's flat.
Year over year as we guided.
With the headwind.
From the useful life change when you correct for that it's about a point higher so I think the real focus here is being able to be aggressive and meeting the demand curve and focusing on the transition and growth in gross margins and.
Delivering the operating leverage.
Okay. Thank you guys.
Thanks, Steve Operator next question please.
Our next question comes from the line of Brent Thill with Jefferies. Please proceed.
Thank you. Thank you on the optimization headwinds that you've continued to see when do you think we hit peak optimization are we getting close to hitting that peak and getting some relief in the back half of the year and maybe AI, helping provided a tailwind.
Any any color from what Youre seeing from your perspective would be helpful.
Sure Brad Thank you for the question.
A couple of observations one is.
I think overall in the cloud you do see.
New project starts and then those are project starts to get optimized and then you sort of time series all of that and that's sort of what you see in the normal course.
What happened here was during the pandemic, obviously, there were lots of new project starts and optimization in some sense.
Was postponed and Thats, where youre seeing I'll call it catch up optimization and Thats something that pure point, we will lap going into the next couple of quarters I think it will come down.
And we are seeing new project starts.
Traditional type of project starts even cloud migrations data applications and of course, obviously the AI applications.
But we will get back to I'll call. It the normal pace of new project starts and optimizations.
Going forward, we will cycle through I think in the next couple of quarters, what is the aloft catch up optimization.
I would just add I think the thought at this point and maybe.
To build a bit of a line for you I think it felt very similar to last quarter. When we made the same comments, which is we're seeing sort of the normal optimization plus we're seeing new workload starts across these.
Workload side, you had talked about and I think that's what we're saying going forward and really what the change is just that lapping of I think a bit of a catch up from a year ago and Youre right. We will continue to do that through through H two.
Yes.
Thanks, Brent Operator next question please.
Yes.
The next question comes from the line of Mark <unk> with Bernstein Research. Please proceed.
Thank you very much.
Taking the question and congrats on the quarter, Amy Capex moved up significantly Q over Q and year over year, and it's increasing moving forward can you give us some color is it physical data centers is predominantly servers is it predominantly AI driven how should we think about the useful life of it and then quickly first.
Satya can you give us some where we a status on the general availability of the full co pilot development stack and how long, it's taking clients and partners to build copilots. Thanks.
Sure.
Well I'll start on the Capex questions after that I'll turn it over to you.
Mark really first of all both in Q4, and then talking about Q1, the acceleration is really quite broad.
Both on.
Both the data centers and a physical basis plus.
Cpus and Gpus and networking equipment I think of it in a broad sense as opposed to through a narrow sense. So it's overall increases of acceleration of overall capacity.
And I think if you look look back over a really FY2023 you wouldn't have seen some of the pace on normal what I would say capacity adds even for the normal Azure workloads, So youre seeing both acceleration and normal Azure workloads, plus some of the AI workloads.
It's partially the reason so it's why I do comment quite often that it's both overall commercial cloud demand and.
Building out capacity for AI, it's both yes.
I think just put perspective, I think it's sort of always good to think about it where we have a one to 111.
Actual cloud business growing.
At quarter, 22% year over year, and then you had a capex growth, which is around the same number 23, 24% so in some sense.
Replacement capital plus some new capital that is going to drive new growth. So that's I think the scale and we feel good about.
That structure of overall.
Growth rates and how it translates into future Tam opportunity for us but to your other question on how all this translates into project starts effectively.
The coupon stack is available today at Ash. So we have everything for all of Azure AI tool chain, where you can use obviously azure open AI or even you can use open models from Lama. Another hugging faced models you have all the fabric and all of our operational data stores for what is one of the most useful batten that generally is what it's called.
Retrieval augment to generation, which is you take the data that you have and the data stores use it in a prompt to generate completion summaries what have you and so that's something that we've seen a lot of co pilot.
Our fundamentally orchestrations of that and so we have all of these services available.
Thing that's fascinating is when you use something like follow virtual agent you have a low code no code tool to build effectively these.
Our products or full fledged copilot flight rebuilt.
And all of the underlying primitives for that are available on Azure. The tool chain is available on azure and the speed with which customers are able to deploy them Isps are able to build them.
Pretty impressive.
Yes.
Thank you I appreciate it.
Thanks, Mark Operator next question please.
The next question comes from the line of Kash Rangan with Goldman Sachs. Please proceed.
Alright. Thank you very much congratulations on the quarter, if I could I just wanted to get your thoughts to shift the discussion away from Cogs and the capex to more of the topline outlook. It looks like Azure growth rate is definitely starting to stabilize and generative AI contribution to Azure is measurably improving quarter by quarter.
And optimization in a broader sense itself is starting to settle down where does this leave.
The company's outlook for Azure growth rate in the future quarters.
Are we at a point, where we've bottomed out and we could start to see some acceleration due to the trends we discussed and also if you take the super set of of Microsoft Cloud when you throw in the new pricing for our copilot. It certainly looks like the temps are opening up in a pretty significant way. So when you take that broader lengths that 'twenty, one 'twenty, 2% growth rate that's out there our neighborhood effort too.
What could be the outlook could we be too optimistic in outstanding hopes of some kind of acceleration in the years ahead or how do you think about the outlook on the top line. Thank you so much.
Sure.
Thanks for the question. So maybe I'll start and then maybe you can add because I think I.
We do think about what's the long term dam here right. I mean this as you heard me talk about this as a percentage of GDP, what's going to be that spend.
And if you believe that let's say the 5% of GDP.
He is going to go to 10% of GDP, maybe that gets accelerated because of the highway bill.
And then the question is how much of that goes to the various parts of our commercial cloud and then how competitive are we in each layer right. So.
If you sort of break it down you talked about how.
Microsoft 365, we think of this co pilot.
Pillar right, we had the creation tools.
Then add all the communication and collaboration services and we think the AI co pilot has been so.
So we are excited about it Amy talked about how we want to get it out first as part of this preview and then into the second half of the next fiscal year, we will start getting some.
Of the real revenue signal from it. So we're looking forward to but we think of it long dove as a third pillar like we thought about something like say teams our share point back in the day or what have you.
Then azure.
The way I think about it is we still are whatever inning, two or three or even the cloud migration, especially if you view it right rather.
Bye.
Industry moves to the cloud segment moved to the cloud as well as country adoption of the cloud right. So they're still.
In early innings of the cloud migration itself. So there's a lot there still.
And then on top of that there is this complete new world of AI driving a set of new workloads.
And so we think of that again being pretty expensive.
Tab opportunity and we'll play it out so but at the same time.
We had a 110 11 billion dollar commercial cloud.
Don.
In <unk> and so therefore.
Law of large numbers, but that said, we do think that this is a business that can have sustained high growth.
Which is something that.
We are excited about.
And I think the only thing cash I would add is.
I think in some ways, what we're really pointing to is.
There's a process here we.
We see the demand signals quite strong it remains strong.
I'm thrilled with all the product announcements, we've made I'm thrilled with them moving to <unk> and then moving to GAA.
Absolutely our expansive in terms of addressable market. They reach new budget pool is almost the way I talk about it a lot in terms of how.
<unk>, our CFO that I talk to think about that investment so a growing opportunity.
And as you know we're focused on executing against that and then revenue is it is an outcome.
But it certainly does require that demand signal requires the capital expense and it creates the opportunity and that's why I think in some ways. We are spending a little more time talking about some of that investment is because it is the demand signal.
Awesome. Thank you so much.
Thanks, Kash operator next question please.
Our next question comes from the line of Karl Keirstead with UBS. Please proceed okay, Greg Amy if I could double click a little bit on the <unk>.
Exciting news around <unk> hundred 65, copilot as everybody on the line looks to layer that opportunity into our models. So I just wanted to.
Get your views are there any guardrails you'd offer us to sort of keep us in line is there a degree of gross margin pressure in the office segment in other words is it a fairly cost intensive new product that we should keep in mind that also could it pull along azure in the sense that you need Azure a D and <unk>.
Some of the other cyber.
Cyber security products, so a little color there Mike might help everybody with their modeling exercise Tonight and in the coming weeks.
Thanks Carl.
Thank.
Maybe I'll first start with the process, we have when we release new product.
And I absolutely understand we are excited by the demand signal the customer reaction.
Really the requests we're getting to be in the paid three view, it's all that's all encouraging.
As you know last week, we announced pricing.
Then.
We'll continue to work through the paid preview process get good feedback then we will announce the general availability date, then we will get to the GAA date then.
We will of course be able to sell it and then recognize revenue and that is why I continue to say that I am just as excited as everyone else about this and it should be more H two weighted.
And we've I think giving you some sizing opportunities and I think that would use all of that but I do think this is really.
About pacing and of course, we still got to get our security co pilot and somebody that dynamics workload.
And released and we will continue to work toward that.
And of course I think.
One of the things that people often I think overlook is I was hoping you mentioned it briefly when you go back to the prolong Azure.
In many ways what.
Product pull along Azure because it's not just the AI solution services that you need to build an app.
And so it's less about Microsoft 365, pulling it along or any one co pilot.
When you're building these it requires data.
<unk> the AI services, so you'll see them pull both core Azure and Azure.
Azure, along with them and I think that's an important important nuance as well yes.
Just add to what Amy said.
Platform effect is really all about the extensibility of the co pilots.
Youll see that today when people build applications and teams that are built on power apps and those power apps happened to use something like sequel, DB on Azure. That's a classic line of business extension. So you'll see the same thing, but I have a copilot plugging that plugging uses azure AI azure meters.
As your data sources.
Semantic search.
So youll see obviously, a bold through not only on the identity or security layer.
But in the core Paas services of Azure, plus the copilot extensibility and entry six five.
Terrific. Thank you thanks.
Karl Operator next question please.
The next question comes from the line of Mark Murphy with J P. Morgan. Please proceed.
Yes. Thank you very much Satya theres, so much to evidence now that.
Github copilot as boosting developer productivity by 40% to 50% or more and it's resulting in higher quality code do you envision a similar level of productivity boost for the Microsoft 365 co pilots are the security Copilot sales co pilot in other words can every room of the house B.
Remodeled.
To a similar extent such that that value proposition is pretty elevated across the entire stack.
Jetson Molotov, we'd love you for having used as metaphor of remodeling every room of the house with AI.
You're absolutely right I mean, that's the opportunity we see I think what you're also referencing is now there is good empirical evidence and data.
Around co.
Copilot and the productivity stats around it and we are actively working on that for <unk> hundred six five co pilot.
Also for things like the rules based ones like sales co pilot our service copilot, we see these business processes, having very high productivity gains and so yes over the course of the year. We will have all about evidence and I think at the end of the day as Amy referenced every CFO and CIO is also going to take a look at this I do.
Inc. For the first time I do think people are going to look at how can they complement the opex spend.
Essentially these co pilots in order to drive more efficiency and quite frankly, even reduce the burden.
And drudgery of work on their Opex.
And people and so on so therefore, I think you're going to see all of that translated into productivity stats and we're looking forward to getting that data out.
Thank you very much.
Operator next question please.
The next question comes from the line of Alex Zukin with Wolfe Research. Please proceed.
Hey, guys. Thanks for taking the question I guess, maybe just a multipart you mentioned a couple of times that with the AI workload adoption that you're seeing on Azure, it's starting to look maybe a little bit different from an incremental share gain perspective versus previous year can you maybe expand upon that how should that drive or azure consumption.
Particularly as we get through the year and do you see a scenario where either the.
Combination of lapping the optimization headwinds plus the AI contribution plus incremental tailwind that you're seeing around the workloads actually does drive a reacceleration at Azure, particularly in the second half when youre going to start to see some of those things kick in.
Yes.
Debt.
We are both seeing and excited about it.
Both the new work with I mean, if you think about Azure.
We.
Have grown azure over the years.
Coming from.
From behind.
And here we are.
As a strong number two.
In the lead when it comes to these new workloads. So for example, we are seeing.
<unk> new logos.
Customers, who may have used to out of the cloud.
Most of what they do.
For the first time sort of starting to use azure for some of the new AI workloads.
We also have even customers who used multiple clouds, who used us for a class of workloads also start new projects. When it is in data and AI, which they were using other clouds. So what I think you will see us is more share gains.
More logo gains, reducing our CAC even.
And so those are the things the points of leverage but at the same time, we are not a small business anymore in any of these things.
Significantly we have significant scale.
And so yes, we celebrate that's why we've been giving you the visibility of one point of it showing up this quarter a couple of points showing up next quarter and those are material numbers.
And so that's kind of what I think we're tracking I think Amy mentioned it because we want to.
Two parts to even though they are right. There is the models themselves with our partnership with open AI, that's sort of what type of spend on compute and the other is much more revenue driven right, which is we would track maintenance costs due to the revenue and demand then.
You are already seeing both of those play out.
Thanks Al. Thank you operator, we have time for one last question.
Our last question will come from the line of Kirk maternal with Evercore ISI. Please proceed.
Yes, Thanks for squeezing me in Saudi I was wondering if you could expand a little bit on your comments on data platforms. I think we've heard a lot over the last quarter or so about if you don't have a data strategy. It's tough to have an AI strategy could you just talk about where customers are right now in that journey to have a more I guess thoughtful data strategy.
And what does that mean in terms of their ability to adopt AI services, meaning do they have to sort of tackle the data issue first before they can really take advantage of all the AI services are or how should we think about that sort of juxtaposition. Thanks.
Yes sure. Thank you for the question, yes, absolutely I think.
Having your data in particular in the cloud is sort of key to how you can take advantage of essentially the new AI reasoning engines to complement I'll call. It your databases because these these AI engines in our databases, but they can reason over your data to help you then get more insights more completions more.
Addictions.
More summaries and what have you. So those are the things when we say co pilot design path and that's sort of what.
Did that patent is all about the thing that perhaps even in the last quarter and I had that in my remarks. That's most exciting is how with Microsoft fabric, especially for the analytics workloads.
Brought together compute storage governance with a very disruptive business model I mean to give you a flavor for it right. So you have your.
Data in Azure data Lake.
Can bring sequel to it you can bring spark to it you can bring azure AI or Azure open AI to it right. So the fact that you have storage separated from all of these compute meters and Theyre all interchangeable right. So you don't have to buy each of these separately that's the disruptive business model So I feel.
Microsoft is very well positioned with the data.
Data architecture lays out our business model around data and how people will plan to use data with AI services.
So that's kind of what I mean by getting your data has stayed in order and it's just not getting data as Jade in order, but you have to have it structured such that you can have the flexibility that allows you to exercise the data and compute in combinations that makes sense for this new age.
Thanks, Kurt that wraps up the Q&A portion of today's earnings call. Thank you for joining us today and we look forward to speaking with all of you soon thank you all.
Okay.
Okay.
Thank you everyone. This concludes today's conference you may disconnect your lines at this time thank.
Thank you for your participation.
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